Governments must beware the lure of free money

Budget constraints have gone missing. That presents both danger and opportunity

It is sometimes said that governments wasted the global financial crisis of 2007-09 by failing to rethink economic policy after the dust settled. Nobody will say the same about the covid-19 pandemic. It has led to a desperate scramble to enact policies that only a few months ago were either unimaginable or heretical. A profound shift is now taking place in economics as a result, of the sort that happens only once in a generation.

Much as in the 1970s when clubby Keynesianism gave way to Milton Friedman’s austere monetarism, and in the 1990s when central banks were given their independence, so the pandemic marks the start of a new era. Its overriding preoccupation will be exploiting the opportunities and containing the enormous risks that stem from a supersized level of state intervention in the economy and financial markets.

This new epoch has four defining features. The first is the jaw-dropping scale of today’s government borrowing, and the seemingly limitless potential for yet more. The imf predicts that rich countries will borrow 17% of their combined gdp this year to fund $4.2trn in spending and tax cuts designed to keep the economy going.

They are not done. In America Congress is debating another spending package. The European Union has just agreed on a new stimulus funded by common borrowing, crossing a political Rubicon.

The second feature is the whirring of the printing presses. In America, Britain, the euro zone and Japan central banks have created new reserves of money worth some $3.7trn in 2020.

Much of this has been used to buy government debt, meaning that central banks are tacitly financing the stimulus. The result is that long-term interest rates stay low even while public-debt issuance soars.

The state’s growing role as capital-allocator-in-chief is the third aspect of the new age. To see off a credit crunch, the Federal Reserve, acting with the Treasury, has waded into financial markets, buying up the bonds of at&t, Apple and even Coca-Cola, and lending directly to everyone from bond dealers to non-profit hospitals.

Together the Fed and Treasury are now backstopping 11% of America’s entire stock of business debt. Across the rich world, governments and central banks are following suit.

The final feature is the most important: low inflation. The absence of upward pressure on prices means there is no immediate need to slow the growth of central-bank balance-sheets or to raise short-term interest rates from their floor around zero.

Low inflation is therefore the fundamental reason not to worry about public debt, which, thanks to accommodative monetary policy, now costs so little to service that it looks like free money.

Don’t fool yourself that the role of the state will magically return to normal once the pandemic passes and unemployment falls. Yes, governments and central banks may dial down their spending and bail-outs.

But the new era of economics reflects the culmination of long-term trends.

Even before the pandemic, inflation and interest rates were subdued despite a jobs boom.

Today the bond market still shows no sign of worrying about long-term inflation. If it is right, deficits and money-printing may well become the standard tools of policymaking for decades.

The central banks’ growing role in financial markets, meanwhile, reflects the stagnation of banks as intermediaries and the prominence of innovative and risk-hungry shadow banks and capital markets.

In the old days, when commercial banks ruled the roost, central banks acted as lenders of last resort to them. Now central banks increasingly have to get their hands dirty on Wall Street and elsewhere by acting as mammoth “marketmakers of last resort”.

A state with a permanently broader and deeper reach across the economy creates some opportunities. Low rates make it cheaper for the government to borrow to build new infrastructure, from research labs to electricity grids, that will boost growth and tackle threats such as pandemics and climate change.

As societies age, rising spending on health and pensions is inevitable—if the resulting deficits help provide a necessary stimulus to the economy, all the more reason to embrace them.

Yet the new era also presents grave risks. If inflation jumps unexpectedly the entire edifice of debt will shake, as central banks have to raise their policy rates and in turn pay out vast sums of interest on the new reserves that they have created to buy bonds.

And even if inflation stays low, the new machinery is vulnerable to capture by lobbyists, unions and cronies.

One of monetarism’s key insights was that sprawling macroeconomic management leads to infinite opportunities for politicians to play favourites. Already they are deciding which firms get tax breaks and which workers should be paid by the state to wait for their old jobs to reappear. Soon some loans to the private sector will turn sour, leaving governments to choose which firms fail.

When money is free, why not rescue companies, protect obsolete jobs and save investors?

However, though that would provide a brief stimulus, it is a recipe for distorted markets, moral hazard and low growth. Fear of politicians’ myopia was why many countries delegated power to independent central banks, which wielded a single, simple tool—interest rates—to manage the economic cycle.

Yet today interest rates, so close to zero, seem impotent and the monarchs who run the world’s central banks are becoming rather like servants working as the government’s debt-management arm.

Free markets and free lunches

Each new era of economics confronts a new challenge. After the 1930s the task was to prevent depressions. In the 1970s and early 1980s the holy grail was to end stagflation. Today the task for policymakers is to create a framework that allows the business cycle to be managed and financial crises to be fought without a politicised takeover of the economy.

As our briefing this week explains, this may involve delegating fiscal firepower to technocrats, or reforming the financial system to enable central banks to take interest rates deeply negative, exploiting the revolutionary shift among consumers away from old-style banking to fintech and digital payments.

The stakes are high. Failure will mean the age of free money eventually comes at a staggering price.

EU banks should heed lessons of 2008 crisis

European lenders must tackle bad loans now instead of waiting

The editorial board 

The banking system is at the heart of government efforts to prop up economies as lockdowns are eased
The banking system is at the heart of government efforts to prop up economies as lockdowns are eased © Simon Dawson/Reuters

How safe are the banks? It is a question that was asked during the financial crisis in 2008 and is again rearing its head as the economic cost of the coronavirus crisis becomes clearer. The banking system is at the heart of government efforts to prop up economies as lockdowns are eased. 

Banks are taking much of the strain, extending loans to businesses and consumers whose livelihoods have been taken away by the pandemic.

The concern is that many of these loans will never be repaid. A new report suggests that European banks could face loan losses of up to €800bn over the next three years. The figure is based on a worst-case scenario, including a severe second outbreak of the virus, but it is something to which regulators and bank chief executives need to be alert.

Second-quarter results in coming days, including from Deutsche Bank, will provide greater clarity. Switzerland’s UBS saw profits slip this week as higher provisions for bad loans offset a strong performance in its trading division. 

Buoyant trading revenues also dominated results from the five biggest Wall Street banks and overshadowed a combined $20bn of loan loss provisions for the quarter. But the cheer has proved shortlived, with JPMorgan’s Jamie Dimon already warning of a slowdown in the second half of the year.

Given the severity of today’s financial crisis regulators have relaxed audit rules to allow lenders greater freedom to trim loss-absorbing buffers. Such forbearance from regulators is inevitable over the short term, but the concern is some banks will try to avoid booking large provisions now. They should resist the urge to do so. First-quarter results already showed a wide range of reported loan provisions, underlining the delicate balancing act lenders are being forced into.

Banks today are more resilient than they were 12 years ago, with greater liquidity and higher capital levels. In the US, the Federal Reserve last month compared the buffers of large banks against the losses they might face in a range of coronavirus-based economic scenarios. In the worst-case outcome, the average loan-loss ratio rose to 10 per cent, indicating $700bn in total losses for the sector. This number may be high but even in such a situation, capital buffers at most lenders would not be wiped out; aggregate capital ratios would fall from 12 per cent in the fourth quarter of 2019 to 7.7 per cent.

Europe’s banks might fare less well. They are less profitable than their US peers — which benefit from their large investment banking arms in the current market — and many, in particular those in southern Europe, remain burdened by high levels of legacy debt. Timely loss recognition is critical. Research shows it allows regulators to intervene early if necessary and also helps to prevent excessive risk-taking.

So too, is a realistic approach to the thorny issue of how long restrictions on buybacks and dividend payouts should remain in place. In the US, the Fed told several banks as part of its stress test results that they had to preserve capital and should cap dividend payments and suspend share repurchases in the third quarter. 

The approach is sensible. In recent years, share repurchases have represented about 70 per cent of shareholder payouts from large US banks. European executives — and banking regulators — should take their lead from the Fed and proceed with similar caution.

Much better to bear the ire of bank executives and short-termist shareholders than run the risk of the pandemic turning into a threat to the stability of the financial system.

Sprott Monthly Report

Gold Attains Escape Velocity

Paul Wong, CFA, Market Strategist

The precious metals complex set off fireworks in July as gold bullion reached all-time highs.

Silver bullion and gold mining equities broke through significant long-term resistance levels to further improve their bullish standing.

Year to date, the precious metals complex continues to outperform as gold has attained "escape velocity," i.e., it has gravitationally moved away from other asset classes.*

Gold bullion(1) was up 30.22% YTD through July 31, 2020, and 39.76% YOY. At the same time, gold mining equities (SGDM)(2) gained 47.70% YTD, and 61.54% YOY as of July 31. This compares to 2.38% YTD and 11.96% YOY returns for the S&P 500 TR Index.(6) Silver posted outsized gains in July and is up 36.62% YTD and 49.95% YOY as of July 31.

July Was Gold's Biggest Monthly Gain Since 2012

Gold bullion rose $195 per ounce, or 10.9%, in July to close at $1,976, an all-time high and the most significant monthly move for gold since 2012. The previous all-time high was $1,921 made nine years ago on September 6, 2011.

Gold has now reached all-time highs in every major currency, and conversely, every currency is at an all-time low in gold terms. Gold started its July move as the U.S. 10-YR Treasury real yield decline accelerated, and was capped off by the plunging U.S. dollar (USD).

Figure 1. Gold Delivers Outsized Returns YTD 2020

figure 1. gold delivers outsized returns ytd 2020
Source: Bloomberg. Data as of 7/31/2020. Gold is measured by GOLDS Comdty; Gold Equities are measured by GDX; the U.S. Dollar is measured by DXY Curncy; U.S. Treasuries are measured by the Bloomberg Barclays US Treasury Total Return Unhedged USD (LUATTRUU Index); the S&P 500 TR is measured by the SPX; and the Nasdaq 100 is measured by the QQQ ETF. Past performance is no guarantee of future results.

Yields Continue to Head Lower with Fed Support

In recent commentaries, we highlighted that real yields would see a pronounced decline once it became clear that nominal yields would be held constant. A combination of QE (quantitative easing), forward guidance and the market beginning to price in a semblance of yield-curve control (YCC) was anchoring nominal yields.

As the recovery took hold, breakeven yields began to rise, reflecting the prospect of recovery.

With nominal yields flat, real yields by default began to collapse. U.S. 10-YR real yields have now fallen below 2012 all-time lows and are likely to head lower (currently at -1.03%).

Gold bullion reaches as all-time high, and the stage has been set for gold to climb even higher.

However, the dynamic in this cycle is different from 2012. Negative real yields are now a Federal Reserve (Fed) objective and have all the firepower of the Fed behind them.

This "higher growth outlook equals higher gold prices" causation will be the opposite of the experience of the past decade (which was marked by the 2011-2019 gold bear cycle).

In a post-COVID-19 pandemic environment, rising growth expectations will mean lower negative rates. This negative yield policy is one of the primary tools the Fed will use to debase the growing U.S. debt burden.

Down the road, if economic conditions worsen or do not improve, we can envision Fed policy moving from capped nominal yields to capped real yields with obvious bullish consequences for gold.

The stage has been set for gold to continue to climb higher. We see increased fiscal spending ahead, extremely accommodative monetary policy in place for years and a challenging economy recovery (as stated by the Fed).

Until this changes, gold will continue to benefit. We believe that gold's latest price surge is likely the result of investors moving towards our long-held view as gold as a store of monetary value and a unique asset class with diversification qualities.

In recent commentaries, we have argued that gold has developed into an asset class with both long duration and short duration qualities, and an asset with positive convexity features. July's price action confirms our view.

Figure 2. Gold Projection Targets $2,000 to $2,200

figure 2. gold projection targets $2000, then $2,200
Source: Bloomberg. Data as of 7/31/2020.

U.S. Dollar Weakness Likely to Persist

The other Fed policy objective would be to keep the USD from strengthening in an uncontrolled manner; even better, would be a steady path to lower levels. Before the COVID-19 outbreak, we were beginning to see the USD peak.

But the pandemic induced a financial system crisis in March 2020 that saw the USD surge as a
flight-to-safety flow took hold and, with it, rising USD funding stress. March was a wake-up call that an overly strong USD is a threat to the global growth outlook, given its ability to shutdown liquidity.

The Fed was well aware of the danger of a USD funding crisis. Of all the credit and swap facilities the Fed launched during the crisis, the USD repo and swap lines were one of the most successful and widely tapped.

Since then, U.S. interest rates are now at the lower bound and likely trapped there, there is no yield advantage, USD safe-haven flows have reversed and any currency volatility would make a carry trade difficult.

The USD weakness is also reflecting the resurgence of COVID-19 cases across the U.S. As more states pause or rollback re-openings (now about 75% of the population), a full and sustainable economic recovery is at risk of either being delayed or becoming less likely.

The weaker and further out the U.S. economic recovery, the more fiscal stimulus will be needed and the longer extreme monetary policies are likely to continue.

The risk is that U.S. unemployment will reset at a much higher structural level, and consumer spending will remain in a state of prolonged weakness.

As the Fed acknowledges, a sustainable U.S. economic recovery requires that the virus be brought under control. To date, there have been few signs that a federal, all-out coherent effort at containment and eradication is forthcoming.

On the present course, the U.S. economic recovery is likely to lag other developed economies that have already flattened their COVID-19 curves.

Other Factors Contributing to USD Softness

The Euro began its rebound earlier in the month as the EU (European Union) appeared to be finally getting its act together on the fiscal front after several decades. The EU's USD $2.8 trillion economic recovery plan includes fiscal burden sharing, the first sign of budgetary unity in a significant way.

The fiscal stimulus for the EU will be at 44% of GDP, roughly the same as the U.S. Another point is the EU is more tied to China trade than the U.S. The data from China continues to show surprising strength, though it remains supply-side weighted.

On the domestic causes of the weak USD, there is an expected heavy U.S. Treasury issuances to finance future fiscal stimulus, dysfunctional and divisive U.S. politics, continuing civil unrest, potentially even higher spending under a Biden agenda and the growing twin deficits.

On the non-domestic causes of a weak USD, more sovereigns are diversifying away from the USD, driven by the concern of further weaponization of the USD, the U.S. financial system and trade (i.e., sanctions, tariffs and other arbitrary penalties).

In its July FOMC (Federal Open Market Committee) meeting, the Fed announced an extension of the central bank dollar repo and swap lines to March 2021. This guarantee of ample USD supply will likely keep a lid on a runaway USD, reducing a right tail risk repeat of the March USD driven funding squeeze and liquidity stress. The safe-haven flight will continue to fade further with the extension of USD swaps and repo lines.

At the shorter end of the real yield curve, there is further room for deeper negative short-term yields. The short end of the real interest rate curve will have a more direct impact on further USD weakness. The introduction of YCC will also have a significant effect on the shorter end of the curve, and if introduced, we would likely see another leg of USD weakness.

DXY (U.S. Dollar Index) has triggered an intermediate top on the charts and is developing a significant long-term topping pattern in the form of a potential double top (Figure 3). None of the arguments for a weaker USD is short term in nature; we expect USD weakness will be long term in nature.

Figure 3. DXY Large Long-Term Topping Pattern Developing, Intermediate Top in Place

figure 3. dxy large long-term topping pattern developing, intermediate top in place
Source: Bloomberg. Data as of 7/31/2020.

Silver Breaks Out as it Plays Catch-Up to Gold

Spot silver surged $6.18 an ounce, or 33.95%, in July to close the month at $24.39, a seven-year high. Silver decidedly broke through the prior formidable resistance of $21/$22 with relative ease.

The next resistance level of $26/$27 remains, but given the momentum, accumulation and further potential buying in futures, we expect this level will be surpassed soon to open the $30-$35 trade range.

Silver is acting both as a store of value and leverage to economic growth...Spot silver surged 33.95% in July to close the month at $24.39, a seven-year high.

Most notable was the explosion in options volume in iShares Silver Trust (SLV), the largest silver ETF. Total open interest had climbed steadily to record levels. Options volume, however, has increased nine times its average daily volume, indicating that buying interest has now widened considerably, likely by larger investors that were not involved in silver earlier.

We view the $21/$22 breakout level on silver as analogous to the $1,350/$1,375 breakout level on gold bullion, and the $26/$27 level on silver as the rough equivalent to $1,600 gold (see Figure 4). Silver continues to have plenty of scope for a catch-up trade to gold bullion.

Figure 4. More Upside Ahead for Silver

figure 4. more upside ahead for silver
Source: Bloomberg. Data as of 7/31/2020.

Silver ETF Flows Reach Record Highs

The fundamental picture for silver continues to improve. As governments look to bolster economic growth, we already see fiscal stimulus directed at intensive silver areas such as solar energy and 5G networks (fifth generation technology standard for cellular networks).

But the most significant surge in demand is from investor flows into silver-backed ETFs. Silver held in ETFs has increased 272 million ounces or 44.7% YTD, reaching a new record high of 878 million ounces of silver. YTD, the 272 million ounces added to ETF holdings, represents about 27% of 2019 total demand numbers.

As with the recent price surge in gold, investor interest in silver is focused primarily on the metal's value as a store of monetary value. Investor demand for gold and silver is highly correlated to U.S. M2 money supply.(7) Where gold buying (using Total Known Gold ETF Holdings from Bloomberg) has a 91% R-square (8) with M2 over the past five years, silver has a still very high R-square of 79%.

Silver also has an industrial component, and its correlation to copper (a proxy for cyclical growth) is quite high at a 57% R-square. By comparison, gold has almost no correlation to copper, as reflected by a 5% R-square.

Currently, silver is acting both as a store of value and leverage to economic growth, a very unusual but highly valuable quality in this current market environment. This latter point may help explain the surge in SLV option activity.

Gold Mining Equities: Multi-Year Breakout to Higher Levels

Gold mining equities had a decisive breakout in July. GDX had a stellar July, increasing 17% to close at $42.94, an eight-year high.

The $40 mark was a critical resistance level that defined the technical breakdown back in 2013.

The $40 resistance on GDX was the chart equivalent of $1,600 on gold bullion.

The break of $40 on GDX was a critical marker for the next bullish phase higher, which now targets the $50 - $55 range. YTD 2020, the average gold price so far is $1,678, or +20.5% higher than the 2019 average price of $1,393. As a reminder of the significant operating leverage for gold miners, using an AISC (All-in Sustaining Cost) of $1,000/oz, operating margins would be $678/oz using 2020 YTD pricing versus $393/oz for 2019, or 72.5% higher.

With five more months to go in 2020, the average realized gold price for 2020 would be significantly higher than $1,678.

Consensus price decks used for earnings estimates remain considerably below the current futures prices. Using Bloomberg data, consensus analysts' price decks are almost $100/oz below the combined realized and futures price curve for 2020.

Next year for 2021, the gap is even wider at $239/oz (futures curve versus consensus price deck). In terms of the following factors that the market is currently rewarding: sales growth, momentum, earnings surprises and target revision, we would expect gold mining equities to rank among the better performing categories merely by having the consensus price deck move up towards current pricing levels.

Year over year, GDX has increased 62.04%, and we see further upside. With GDX breaking above $40, gold equities are entering the next bullish phase — acceptance of the bull market (Figure 5a). The very long-term trends are now showing gold equities on the verge of breaking relative to gold bullion and relative to even the S&P 500 Index (Figure 5b).

In the prior cycle, gold equities outperformed the S&P 500 sevenfold over ten years, a surprising fact for many new participants perhaps, and possibly forgotten by many older ones.

Figure 5a. Gold Mining Equities Breaking Out to Next Price Target Range of $50-$55
 figure 5a. gold mining equities breaking out to next price target range of $50-$55
Source: Bloomberg. GDX data as of 7/31/2020.

Figure 5b. Gold Mining Equities Relative to Gold Bullion and S&P 500: On the Verge of Major Breakout from Multi-Year Bases
figure 5b. gold mining equities relative to gold bullion and s&p 500: on the verge of major breakout from multi-year bases
Source: Bloomberg. Data as of 7/31/2020.

Economic Outlook?
Cloudy with a Chance of W, Wavy and Other Oddly Shaped Recoveries

Q2 U.S. gross domestic product (GDP) figures were released last week and, as expected, was horrific. Q2 GDP was down 32.9% on an annualized basis (-9.5% for the quarter), the worst number in living memory.

The COVID pandemic-induced sudden stop and now gradual and uneven re-opening of economies will create some abnormal and contradictory economic data points for a while yet.

The U.S. economic outlook remains mixed but has slipped recently as the number of COVID cases continues to escalate. With more than 75% of the population in states that are re-instituting lockdowns or delayed re-openings, recovery momentum will likely slow.

At the time of this writing, Phase 4 of the virus relief stimulus bill is currently stalled between Senate Republicans and House Democrats.

A sustainable V-shaped recovery scenario is highly questionable, given that 32 million Americans are claiming some form of unemployment insurance. Much of that imagined V-shaped recovery was likely due to the individual stimulus checks that have just run out.

No Country Has Been Untouched by COVID

The lasting damage from COVID will likely become more evident in the second half of 2020, once the shock and awe of the monetary and fiscal stimulus have settled. Growing job losses, classified as permanent, and increased bankruptcies are likely to indicate structural changes making their way through the U.S. economy.

Given that other countries continue to struggle with a second wave of COVID infections as well, a complete recovery is a challenging long-term task. Virtually no country has been untouched.

Every developed economy has initiated massive monetary and fiscal stimulus programs that have resulted in debt exploding to levels not seen in several decades or ever.

This coming fall, expected Treasury issuance will be faster than QE buying, potentially increasing yields. Yield-curve control remains a possibility as the Fed will need to contain interest rates by monetizing all fiscal stimulus programs. The economy will continue to require very accommodative financial conditions for years.

With monetary policy already at zero interest rates, and QE at massive levels, implementing yield-curve control may become necessary. The increased fiscal stimulus outlook is also timely as YCC is most effective when coordinated with fiscal stimulus.

The Precious Metals Bull Market Should Continue to Strengthen

Gold has staged a breakout in a spectacular manner driven by plunging real yields, and now with the USD topping out. Deep negative real yields and a falling USD are potent drivers for gold. All these factors are related, and all are likely to continue.

The current fiscal relief bill will have a $1 trillion floor, and more future relief spending is expected and sizeable fiscal stimulus programs will continue. Extreme accommodative monetary policy is here to stay indefinitely, even if conditions improve.

The USD has just started a major down leg. All the arguments we have made for being bullish on precious metals over the past year remain in place and have only accelerated or magnified.

We continue to predict that gold will remain in a multi-year bull market.

*Escape velocity is the minimum velocity that a moving body (such as a rocket) must have to escape from the gravitational field of a celestial body (such as the earth) and move outward into space.

1 Gold bullion is measured by the Bloomberg GOLDS Comdty Index.

2 Sprott Gold Miners Exchange Traded Fund (NYSE Arca: SGDM) seeks investment results that correspond (before fees and expenses) generally to the performance of its underlying index, the Solactive Gold Miners Custom Factors Index (Index Ticker: SOLGMCFT). The Index aims to track the performance of larger-sized gold companies whose stocks are listed on Canadian and major U.S. exchanges.

3 VanEck Vectors® Gold Miners ETF (GDX®) seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the NYSE Arca Gold Miners Index (GDMNTR), which is intended to track the overall performance of companies involved in the gold mining industry.

4 The U.S. Dollar Index (USDX, DXY, DX) is an index (or measure) of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies.

5 Commodity Futures Trading Commission's (CFTC) Gold Non-Commercial Net Positions weekly report reflects the difference between the total volume of long and short gold positions existing in the market and opened by non-commercial (speculative) traders. The report only includes U.S. futures markets (Chicago and New York Exchanges). The indicator is a net volume of long gold positions in the United States.

6 The S&P 500 or Standard & Poor's 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies.

7 M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money. M2 is a broader measure of the money supply that M1, which just include cash and checking deposits (Source: Investopedia).

8 R-squared values range from 0 to 1 and are commonly stated as percentages from 0% to 100%. An R-squared of 100% means that all movements of a security (or another dependent variable) are completely explained by movements in the index (or the independent variable(s) you are interested in) (Source: Investopedia).

Paul Wong

Paul has held several roles at Sprott, including Senior Portfolio Manager. He has more than 30 years of investment experience, specializing in investment analysis for natural resources investments. He is a trained geologist and CFA holder.

Gold Prices Hit Record as Dollar Drops

Weakening dollar adds momentum to gold’s summer surge, propelling metal above 2011 intraday peak

By Joe Wallace

Gold prices zoomed to a record Monday, as a weakening dollar injected new momentum into a rally driven by uncertainty about the world economy.

Futures contracts for delivering gold in August shot up as much as 2.2% to $1,940.10 a troy ounce, topping the previous intraday peak of $1,923.70 from September 2011. They ended the day up 1.8% at $1,931, a second consecutive closing record. Gold futures reached an all-time closing high for the first time in nearly nine years Friday, but remained short of the intraday record.

Monday’s record marked a milestone in gold’s bull run, which many traders rank alongside those of 2008-11 and the late 1970s. The gloomy outlook for the world economy, a decline in interest rates, rising tensions between the U.S. and China, and the dollar’s depreciation have fueled the surge as investors have bought assets they perceive to be havens.

GOLD VIDEO: blob: 
“There are still a lot of things to be worried about, which is why gold is attracting all this attention and all this money,” said David Govett, head of precious metals at commodities brokerage Marex Spectron.

“You’re seeing money slipping out of the stock market or out of other assets and just eking into gold,” Mr. Govett added. “Gold, as a small market, is moving a long way as a result.”

The advance marked gold’s seventh consecutive daily advance, the metal’s longest winning streak since February. Gold prices have gained nearly 9% over the past month and about 27% this year, making the metal one of the strongest-performing major assets in 2020.

The price of silver, seen as a store of value by investors as well as having widespread industrial uses, rose even more sharply than gold Monday. Futures for September delivery, the most widely owned contracts, jumped 7.2% to $24.501 an ounce, the highest level in almost seven years.

Adding impetus to gold and silver Monday was a weakening in the dollar, which made the precious metals more attractive to investors overseas. The ICE U.S. Dollar Index, which tracks the dollar against the currencies of six trading partners, fell Monday, extending a recent slide that has it on track for its worst month in nearly a decade.

Gold’s traditional inverse relationship with the dollar had frayed this year, as both assets benefited from haven buying during the pandemic. It is now reasserting itself, a factor that will boost gold in the coming months if the dollar continues to slide, said Joni Teves, precious-metal strategist at UBS Group.

Still, “the move in gold this year has really been driven by rising strategic interest,” said Ms. Teves. Investors who were previously uninterested in the precious metal are now buying it, a trend that could lift prices above $2,000 an ounce within six months, she added.

Shares of precious-metals miners including Barrick Gold Corp. GOLD -0.66% and Newmont Corp. NEM -1.52% benefited from Monday’s advance in gold and silver, extending their recent gains. Some gold-mining stocks are now up more than 50% this year.

Gold prices have leapt in London, the main hub for buying and selling gold bars, as well as in New York’s futures market. In Friday’s auction, prices topped $1,900 for the first time since the Bank of England and N.M. Rothschild & Sons Ltd., now investment bank Rothschild & Co., founded the daily price in 1919.

One factor that distinguishes the current surge in gold prices from the bull run during and after the last global financial crisis is the fragile state of demand for physical metal. Lockdowns and economic uncertainty have crimped jewelry purchases in India and China, normally two huge bullion markets.

So far, a burst of buying by investors has more than offset the dearth of jewelry demand. But if financial demand dries up, prices could fall without physical consumption to act as a cushion for prices, said Ms. Teves.

Investors who wouldn’t normally be active in the market until European and U.S. hours bought gold in thin Asian trading Monday, exaggerating the rise, according to Mr. Govett. “London this morning is a little bit shellshocked,” he said.

However, Mr. Govett added that gold could be knocked off course in the event of a correction in the stock market that prompts investors to sell precious metals to meet margin calls.

One strategist said gold prices could rise above $2,000 an ounce within six months.

From American to European Exceptionalism

An overvalued US dollar is ripe for a sharp decline, owing to America’s rapidly worsening macroeconomic imbalances and a government that is abdicating all semblance of global – or even domestic – leadership. And the European Union's approval of a joint rescue fund is likely to accelerate the euro's rise.

Stephen S. Roach

roach118_Artur WidakNurPhoto via Getty Images_currency

NEW HAVEN – Those are tough words to swallow for a hardcore Euroskeptic. Like many, I have long been critical of Europe’s Economic and Monetary Union as a dysfunctional currency area.

Notwithstanding a strong political commitment to European unification as the antidote to a century of war and devastating bloodshed, there was always a critical leg missing from the EMU stool: fiscal union.

Not anymore. The historic agreement reached on July 21 on a €750 billion ($868 billion) European Union recovery fund, dubbed Next Generation EU, changes that – with profound and lasting implications for both an overvalued US dollar and an undervalued euro.

Unlike the United States, which appears to be squandering the opportunities presented by the epic COVID-19 crisis, Europe has risen to the occasion – and not for the first time. In July 2012, in the depths of a seemingly fatal sovereign debt crisis, then-ECB President Mario Draghi vowed to do “whatever it takes” to defend the beleaguered euro.

While that pledge solidified the European Central Bank’s credibility as an unshakable guardian of the single currency, it did nothing to address the greater imperative: the need to trade national sovereignty for a pan-European fiscal transfer mechanism.

The July 21 agreement accomplishes just that. And now the EMU stool finally has all three legs: a common currency, one central bank, and a credible commitment to a unified fiscal policy.

Of course, the deal is far from perfect. Significantly, it requires unanimous consent from the EU’s 27 member states – always a nail biter in today’s charged and polarized political environment. And there was a major tug of war over the composition of the EU fund, which will comprise €390 billion in one-off COVID relief grants and €360 billion in longer-duration loans.

While the devil could lurk in the details, the bottom line is clear: the Next Generation EU plan will draw critical support from large-scale issuance of pan-European sovereign bonds. That finally puts Europe on the map as the backer of a new risk-free asset in a world that up until now has only known only one: US Treasuries.

Europe’s fiscal breakthrough drives an important wedge between the overvalued US dollar and the undervalued euro. Recent trading in foreign-exchange markets now seems to be catching on to this. But there is a long way to go. Notwithstanding a surge in June and early July, the broad euro index remains 14% below its October 2009 high in real terms, whereas the dollar, despite weakening in recent weeks, remains 29% above its July 2011 low.

My prediction of a 35% drop in the broad dollar index is premised on the belief that this is just the beginning of a long-overdue realignment between the world’s two major currencies.1

I fully recognize that currency calls have long been the trickiest macro forecasts of all. Former US Federal Reserve Chairman Alan Greenspan famously put them on a par with coin tosses. Still, sometimes it pays to take a stab.

My bearish view that an overvalued dollar is ripe for a sharp decline reflects two strains of analysis: America’s rapidly worsening macroeconomic imbalances and a government that is abdicating all semblance of global leadership. The July 21 breakthrough in Europe, and what it means for the euro, only deepens my conviction.

On macro imbalances, the precipitous decline in US domestic saving that underpinned my original argument now seems to be well under way. The initial pandemic-related spike in personal saving now seems to be receding, with the personal saving rate falling from 32% in April to 23% in May, while the federal budget deficit is exploding, spiking to $863 billion in June alone – almost equaling the $984 billion shortfall for all of 2019.

And, of course, the US Congress is just days away from enacting yet another multi-trillion-dollar COVID-19 relief bill. This will put enormous pressure on already-depressed domestic saving – the net national saving rate was just 1.5% of national income in the largely pre-pandemic first quarter of 2020 – and put the current account on a path toward a record deficit.

The comparison with Europe is particularly compelling from this perspective. Whereas the International Monetary Fund expects the US current-account deficit to hit 2.6% of GDP in 2020, the EU is expected to run a current-account surplus of 2.7% of GDP – a differential of 5.3 percentage points.

With the US entering the COVID crisis with a much thinner saving cushion and moving far more aggressively on the fiscal front, the net-saving and current-account differentials will continue to shift in Europe’s favor – putting significant downward pressure on the dollar.

The same is true from the standpoint of global leadership, especially with America pushing ahead on deglobalization, decoupling, and trade protectionism. Moreover, I was particularly impressed by Europe’s latest efforts to address climate change — not only framing Next Generation EU to be compliant with the Paris climate agreement, but also earmarking close to one-third of its broader budget package for green infrastructure and related spending initiatives.

US President Donald Trump has unfortunately gone in precisely the opposite direction, continuing to dismantle most of the environmental regulations put in place by President Barack Obama’s administration, to say nothing of having withdrawn from the Paris accord in early 2017.

The COVID containment disparity is equally striking. New cases in the US soared to a record daily high of 67,000 in the week ending July 21 – up a staggering 208% from mid-June. In the EU-27, the daily count of newly confirmed infections has remained roughly stable since mid-May, at a little over 5,000. Given that the EU’s population is 35% larger, America’s abysmal failure at containing the coronavirus is all the more glaring on a per capita basis.

Moreover, the expansion of coronavirus testing in the US is actually decelerating just as the infection rate is exploding, undermining the Trump administration’s vacuous justification that more testing is driving the rise in infections. With Europe’s much deeper commitment to public-health policy and enforcement, whose currency would you rather own?

American exceptionalism has long been the icing on the cake for the Teflon-like US dollar.

Those days are gone. As the world’s most unloved major currency, the euro may well be headed for an exceptional run of its own. Downward pressure on the dollar will only intensify as a result.

Stephen S. Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China.

A Golden Rule From a Golden Fool

The yellow metal has been white hot this year. But those who rush to buy it could still end up in the red.

By Jason Zweig


Almost five years ago to the day, a market commentator with a prominent platform called gold “a pet rock.” Since then, gold has risen nearly 70%, hitting an all-time high this week.

That market commentator? Yours truly. How wrong was I, and what can we learn from my mistake?

Oh, was I ever wrong. The yellow metal didn’t sit inert. Since I wrote that column five years ago, gold has returned an average of 10.5% annually—barely below the gains on U.S. stocks. And so far in 2020, it’s up 24% even as stocks are as flat for the year as…pet rocks.

Even so, traders and investors who are perennial fans of the yellow metal have a flaw in their thinking, too. They always believe gold is cheap, no matter what, even though they seldom have the same reasons for believing that it’s cheap. That is its own sort of mistake.

Gold is attracting a lot of money in a hurry. Exchange-traded funds, which had $118 billion in gold assets a year ago, now command $215 billion. One-fifth of all that money has flowed in since Jan. 1, according to the World Gold Council, accounting for nearly half of global demand for gold. In the first half of 2020, gold-backed ETFs lured in a record $40 billion, up from $5 billion in last year’s first half.

Such hot money isn’t always sparked by the same thinking. Depending on what worked at the time, gold has been regarded as a buffer against high inflation, protection against a falling dollar or a universal currency that shines brightest when the news is darkest.

“The factors that drive gold prices tend to fluctuate,” says Suki Cooper, head of precious-metals research at Standard Chartered Bank in New York. “It is a fickle kind of asset.”

In the aftermath of the 2008-09 global financial crisis, investors piled into gold on the belief that low interest rates and trillions of dollars in government spending would ignite hyperinflation and make gold more valuable.

Gold shot up close to $1,900 in the summer of 2011, but the hyperinflation never materialized. In real, inflation-adjusted terms, gold gained about 6% annually in both 2011 and 2012, then lost 38% from 2013 through 2015, according to Christophe Spaenjers, a finance professor at the HEC Paris business school in Jouy-en-Josas, France. By late 2015 the gold price had sagged to $1,050.

Gold is, in fact, a poor hedge against inflation. Accounting for changes in the cost of living, gold has returned an average of minus 0.4% annually since 1980, versus positive annualized returns of 7.9% for U.S. stocks, 6.2% for U.S. bonds and 1.2% for cash, according to Prof. Spaenjers.

Adjusted for inflation, he reckons, gold would still have to rise approximately 52% from this week’s prices to match its level of January 1980. That is when it peaked in inflation-adjusted terms.

So you hear less about gold’s purported inflation-fighting powers nowadays. Instead, fans argue the dollar is losing value and, above all, that low interest rates in the U.S. and negative rates elsewhere will drive gold higher.

That makes some sense. It costs money to store and insure gold, which—unlike cash or bonds—produces no income. When the return on cash is nil or negative after inflation, gold’s income disadvantage disappears. Investors then become more willing to “look to assets where the value will at least be retained, which benefits gold,” Ms. Cooper says.

Although I expected interest rates to stay low for a long time, I never thought they would go this low, with even 30-year U.S. Treasury bonds yielding less than 1.3%. Such low rates have fueled high returns for gold.

So the yellow metal, once considered a hedge against an overheated economy, has become a bet against a return to economic growth.

That’s not a sure thing. “The main downside risk to gold is that interest rates may not remain low for a prolonged period,” says Ms. Cooper. A surprisingly swift or unexpectedly strong economic recovery could push interest rates back up, hurting gold.

Another risk: The hot money that has poured in lately might turn out to be even more fickle than the precious metal itself. Just ask anybody who bought gold in 1980 around $850, when speculators lined up on city sidewalks to get their hands on the stuff. By the end of 1981, gold was back under $400.

As I said five years ago, there’s nothing wrong with keeping a few percentage points of your portfolio in gold. That’s especially true if you build that position over time and hold it as lifelong insurance against a collapse in the dollar or as a long-term hedge against low interest rates.

Then, even if gold reverts to being a pet rock, you shouldn’t regret holding it; after all, the purpose of insurance isn’t to obtain high returns, but to protect against risks.

If, however, you’re buying gold by the fistful now that it’s surged in price and popularity, then you run a substantial risk of ending up being as wrong as I have been.